NetApp Inc (NTAP) 2007 Q4 法說會逐字稿

Good day, ladies and gentlemen, welcome to the fourth quarter Network Appliance earnings conference call.

(OPERATOR INSTRUCTIONS) As a reminder this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call, Ms.

Tara Dhillon, Senior Director of Investor Relations.

Please proceed.

Good afternoon, everyone and thank you for joining us today.

Our conference call is being webcast live and will be available for replay on our website at www.NetApp.com along with the earnings release, the financial tables, and the reconciliation between GAAP and non-GAAP numbers.

In the course of today's call, we'll make forward-looking statements and projections that involve risks and uncertainties including statements regarding our expectations with respect to our Q1 pipeline and bookings distribution.

Our operating results for fiscal Q1 and FY '08, our future stock repurchases, our composite positioning, revenue recognition on our new low end, our effective tax rate, the hiring plan, our intention to pay down remaining debt associated with our foreign cash repatriation and the benefits of the investments that we made in emerging products in FY '07.

Actual results may differ materially from our statements or projections.

Important factors that could cause actual results to differ include but are not limited our ability to build non- deferred backlog to levels more consistent with our past results and to increase our revenue over the next several quarters.

Changes in customer demand for products and services, increased competition, and declining general economic conditions and foreign currency exchange rate fluctuation.

Other important factors that could cause results to differ from those in the forward-looking statements are detailed in the risk factors section of our 10-K and 10-Q reports on file with the SEC and accessible through our website.

All of which are incorporated by reference in today's discussion.

We disclaim any obligation to update information contained in these forward-looking statements whether as a result of new information, future events, or otherwise.

With me on today's call are Dan Warmenhoven, our CEO; President Tom Mendoza; Steve Gomo our CFO; and Tom Georgens, our EVP of Product Operations.

Steve will review this quarters financials and discuss our revised financial outlook for the first quarter and then Dan will share his thoughts before we wind up with everyone here for Q&A.

Steve?

Thanks, Tara.

Good afternoon, everyone.

Reported solid fourth quarter and FY '07 results despite some challenges that emerged during the quarter.

Our booking levels during March experienced the same IT spending delays that have been reported by other companies this spring.

Bookings were back end loaded and finished lower than our forecast.

In addition, in the last two weeks of the quarter, we experienced a shift in the mix of our bookings towards more deferred elements.

As a result, we did not build our seasonally normal levels of non-deferred backlog at the end of the fourth quarter.

While not impacting fourth quarter revenue levels, this has obvious implications for Q1 FY '08 given our typically -- given our typical business seasonality.

Without the benefit of normal backlog, we do not expect our usual level of revenue during Q1 and as a result our expense levels will be ahead of our business model.

We will flow our rate of hiring and investment spending in Q1 in order to return to our normal business model and more typical growth rate in the second quarter.

The good news is that our competitive position remains very strong.

Our win rates were solid again this quarter as evidenced by our strong product gross margins and our deferred revenue levels grew at an enormous rate.

As I walk through the specifics of our results please note that all numbers comply with GAAP unless stated otherwise.

Total revenue for the fourth quarter was $801.2 million, up 34% compared to Q4 last year and up almost 10% sequentially.

Foreign currency effect had an immaterial impact on this quarters sequential results but added about 3 percentage points on a year-over-year basis.

The full year FY '07 impact was the benefit of about 2 percentage points year-over-year.

The combination of product revenue and software subscription revenue was $687.3 million, growing 31% year-over-year and 8% sequentially.

Add-on software and software subscriptions accounted for 40% of total revenue this quarter compared to 40% last quarter and 42% in Q4 of last year.

Our add-on software was about 28% of total revenue and software subscriptions were about 12% of total revenue.

Recall that we're using an updated methodology for calculating software that I described in detail at our Analyst day, since all of our storage systems come configured with iSCSI all of the protocols are now included in add-on software.

The figures I just provided reflect the new presentation applied to previous quarters.

Revenue from services which includes hardware support, professional services, and educational services, was 14% of total revenue, up 22% sequentially and up 52% over Q4 of last year.

Service maintenance contracts increased 14% sequentially and 44% year-over-year.

Professional services grew 37% sequentially and 66% year-over-year.

Our ability to deliver more professional services demonstrates the positive impact of our hiring earlier in the year.

Non-GAAP gross margins was 51.8% this quarter.

The combined non-GAAP gross margin for products and software subscriptions was 67.0% down just slightly from last quarter but still demonstrating solid competitive strength.

In fact, this combined gross margin was at the highest Q4 level in the past five years.

Please refer to the table provided in our press release and on our website to see the reconciling items between non-GAAP and GAAP.

Non-GAAP service margins improved to 30.2%.

As expected service margins returned to 30% this quarter after significant hiring dampened margins in the third quarter.

We are targeting these service margins to be in the low 30s through FY '08.

Turning to non-GAAP expenses our operating expenses totaled $373 million or 46.6% of revenue.

Expenses increased 12% sequentially and 41% year-over-year as we absorbed the investment spending and hiring from the third quarter on top of our fourth quarter expenses.

Total headcount increased by 487 people in the fourth quarter ending the fiscal year with 6635 employees.

Net additions in FY '07 were 1659 people.

As we exit Q4, our operating expense structure is slightly higher than the level targeted in our business model and our operating profit plan.

This is primarily the result of the aggressive hiring that we conducted in the second half of the fiscal year.

Because the effect of that hiring will carry forward, we plan to hire only about 200 to 250 people in the first quarter as we work to assimilate the recent new hires and increase our productivity.

After Q1, our hiring will be dependent upon our revenue growth rate in order to stay within our target business model.

GAAP operating expenses include the effect of prior merger related costs by intangible amortization from acquisitions and the effects of FAS 123R.

Non-GAAP income from operations totaled $121.5 million or 15.2% of revenue below our targeted range as a result of the operating expense structure I mentioned earlier.

Non-GAAP other income which consists primarily of interest income was $17 million.

Non-GAAP income before taxes for the quarter was $138.4 million or 17.3% of revenue.

Our effective non-GAAP tax rate remains at 17.5% and our full year effective GAAP tax rate is 17.2%.

The Q4 GAAP tax rate reflects an $18 million favorable adjustment to the full year FY '07 rate.

That adjustment consists primarily of trueing up the estimated mix of foreign employee stock compensation to the actual year-end amount and recognizing a greater than expected California State R&D tax credit.

Non-GAAP net income totaled $114.2 million, or $0.30 per share.

GAAP net income totaled $89.6 million or $0.23 per share.

Our cash generated from operations was $210.7 million this quarter, up 23% over Q4 last year.

Capital expenditures were $53.4 million and free cash flow which we define as cash from operations less capital expenditures totaled $157.3 million this quarter growing 16% over Q4 last year.

While cash flow from operations was still strong, it was down from Q3 primarily as a result of the increase in our accounts receivable.

The increase in accounts receivable was due to the more back end loaded nature of our revenues this quarter.

Over 89% of our accounts receivable are net 30 days or less.

Accounts receivable day sales outstanding were 67 days compared to 55 days reported last quarter and 62 days reported in Q4 last year.

So while it's not unusual to see an increase from Q3 to Q4 at NetApp.

The size of the DSO increase this year was impacted by a lengthening of the deal cycles towards the end of March.

Many deals expected to close in March did not close until April, making it very difficult to collect this April business before the end of the quarter.

Inventory turns increased to 22.5 times this quarter from 18.2 times in Q3.

Turning to other balance sheet metrics, cash and investments totaled $1.3 billion, an increase of about $13 million from Q3.

We repurchased about 5.6 million shares of outstanding common stock at an average price of $35.63 per share for a total cash outlay of $200 million.

Cash and investments exclude $160 million of restricted cash associated with our foreign cash repatriation last year.

The debt on our balance sheet related to this repatriation is currently $85 million.

We paid down approximately $56 million of this debt during the fourth quarter and we expect to pay out the remaining balance within the next 12 months.

Total deferred revenue increased by $158.1 million this quarter to $1.1 billion, a 17% sequential increase and up 62 % year-over-year.

This is another concrete example of the underlying health of our business.

Now, before I turn the call over to Dan for his comments, I'll discuss our target operating model for the first quarter.

Our outlook is based on current business expectations and current market conditions and reflects our non-GAAP presentation.

We are making forward-looking statements and projections that involve risks and uncertainty.

Actual results may differ materially from our statements or projections for the reasons cited earlier.

Because we exited the fourth quarter without a typical seasonal build up in non-deferred backlog, we believe it's prudent to lower our forecast for the first quarter.

We expect Q1 '08 revenue to decline sequentially by 6 to 7% from the fourth quarter, which translates to about a 20 to 21% year-over-year growth rate.

As a result, we expect non-GAAP operating margins to be in the range of 12.5 to 13% below our target range of 15.8 to 16.4%.

This will result in our first quarter non-GAAP earnings of approximately $0.24 to $0.25 per share.

GAAP earnings are expected to be $0.14 to $0.15 per share.

We expect our diluted share count to decrease by about 2 million shares in the first quarter depending upon the stock price.

Given our expectations for the first quarter, we believe it's also prudent to hold off on discussing any revised expectations for the full year.

If the macroeconomic phenomenon that we saw in March this past, we expect to return to our target operating model in the second quarter given our pipeline and our tighter expense control.

For instance, if we post a 10% sequential increase in revenue from Q1 to Q2 and are back at our target operating margin range of around 16% we would be close to our original plan going forward; however, we believe it's too early to make a determination about revenue levels beyond Q1 today because neither April nor May are necessarily good indicators of our steady state business flow due to the unusual circumstances in both months.

Namely, all the accelerator incentives in April and the sales kickoff meetings in May.

We will discuss future expectations with you on our earnings call in August.

Now at this point I'll turn the call over to Dan for his update.

Dan?

Thank you, Steve.

While we're clearly not immune from macroeconomic forces we stretched out our sales cycles in March, it's important to not lose sight of our strong finish to the year and that the fundamental drivers of metrics in our business demonstrate its underlying health.

With 34% year-over-year growth in Q4 and 36% for the full fiscal year, we did have a great year.

Our competitive engagements with EMC increased in the fourth quarter and our win ratio against them remain solid.

Our win rates against Hewlett-Packard increased in Q4 particularly in SAN engagements and the strength of our gross margins indicates that we're maintaining our competitive advantage.

Looking into Q1, we have an ample pipeline, and I expect we will see our normal monthly distribution of bookings.

What Q1 will lack is the non-deferred backlog from Q4 but it's always been necessary to support revenue growth in Q1 of prior years.

We should get a better sense this quarter for whether overall sales velocity has returned to more normal patterns.

In terms of Q4 fundamentals, all the major indicators are positive.

The number of large deals, that is deals over $2 million increased this quarter, as we continue to develop our enterprise customer base.

Total storage system units shipped increased 13% sequentially.

High end FAS 6000 series units increased 35% from Q3 and our mid range FAS 3000 were up 19% sequentially and even the low end FAS 200 series was up yet again this quarter by 6% sequentially despite being the oldest product in our storage line-up.

In Q1 we expect to begin recognizing revenue from our new low end, which will have a favorable effect on penetration and lower price points over the next several quarters.

Our petabytes shipped increased 21% sequentially to over 125 petabytes for the quarter.

ATA drives accounted for 58% of our total petabytes shipped up 26% sequentially and fibre-channel petabytes were up 14% sequentially to 42% of our total shipped.

This quarter, block based protocols were included 41% of our storage business, about the same as last quarter.

Within this, 31% of our business had a fibre-channel SAN component and 18% included iSCSI which we refer to as IP SAN and there were 8 percentage points of overlap where both fibre-channel SAN and IP SAN were included on the same purchase order.

Revenue from our application management software family was up 16% sequentially.

This includes primary storage software products like SnapManager for Oracle, SnapManager for Exchange, SnapManager for SQL server and Data protection software revenues are up 14% sequentially which include secondary storage software like SnapMirror, SnapBlock, SnapRestore, and SnapVault.

As we continue to develop new software, we're seeing our software subscriptions grow, which indicates the enterprise customers appreciate these offerings enough to protect their investment for the long term.

And would also benefit by embedding ourselves for several years.

This provides us with the benefit of higher cash flow and visibility from increased deferred revenues.

We saw this phenomenon particularly in the last few weeks of Q4 as customers bought and renewed subscriptions at record rates.

ONTAP GX, our scale out operating system is also making steady progress both in the market and in development.

We've had some prominent competitive wins and we're beginning to sell in the companies outside of the high performance computing area.

Results from our emerging products were mixed again this quarter which is to be expected from newer products in emerging markets.

The traction and uptick will both be choppier.

The (Inaudible) pulled back a little after a stellar Q3, but finished with a spike in win rates in April.

We like the progress we're seeing from this product line.

Encryption products continue to win technical proofs of concept but are faced with a persistent lack of buying urgency from customers.

Our V Series which provides functionality in front of existing competitive storage arrays was up in units shipped and has gained some terrific prominent reference accounts.

Our SMB product is slowly gaining traction in both units shipped and partner recruitment and our Topio acquisition is off to a great start with revenues and bookings up significantly from last quarter albeit off a very small base.

Despite the mixed success, the emerging products group as a whole did very well for us.

Overall Q4 revenue was more than double that of Q4 of last year.

Geographically about 56% of total revenue came from the Americas, up over 15% sequentially.

The U.S.

revenue performance doesn't reflect a more challenging booking environment particularly near the end of March which is more pronounced in the U.S.

than overseas.

Europe contributed 34% of revenues up about 6% sequentially over their tremendous Q3 performance, and Asia-Pac was about 10% of total revenue, down just under 4% from Q3.

Our indirect channel was up almost 20% sequentially accounting for 63% of revenue.

Contributions from Arrow and Avnet played a significant part in this sequential increase generating 14% of total revenue up about 47% from the third quarter.

Both distributors have responded very well to incentives for driving business through new resellers, and many of those partners really began to flourish in the fourth quarter.

This quarter is also reaping the benefit of our B to B program which has made buying from distribution far easier and faster than any other method and IBM was right in line with our expectations.

Our partner ecosystem drives a healthy portion of our growth and we continue to cultivate deeper relationships with the major application vendors.

We've also achieved global status in our partnership with VMware and they are now one of our top five strategic partners along with the outstanding company of Microsoft, Oracle, SAP, and Symantec.

In summary, our employees can be proud of the strong growth achieved during fiscal year '07.

At the beginning of the year, one of our top five internal goals was grow faster and the NetApp team accomplished just that.

Up 6 percentage points over the 29% growth in FY '06.

There's a lot put in place in those six that paid off.

New products, the IBM relationship, emerging products, and a number of other new initiatives.

These investments will continue to bear fruit next year and beyond.

In Q4 this year, we had a good balance of business overall between primary and secondary storage, between NAS and SAN, international and U.S.

and direct and indirect.

It just took longer to close deals in the second half of the quarter, but our fundamentals remain intact with petabytes up, solid system sales, healthy software contributions, new low end coming, and a competitive position that is as strong as it ever has been, so although we are faced with the first quarter it doesn't have the benefit of typical backlog going in, our pipeline points toward more normal business levels going forward.

But it remains to be seen whether sales velocity is also returning to more normal patterns.

As long as customers return to buying at a normal rate, we will get back on track towards our typical growth profile.

In the meantime, we appreciate what the NetApp team achieved this year, at the same time we're asking them for more frugal with tighter expense controls and to look for ways to increase productivity across the Company and to work hard to bring our new hires up to speed quickly.

At this point I'll open the floor to questions requesting that you limit yourself to one and then return to the queue so we may address everyone in the allotted time.

Operator?

Thank you.

[OPERATOR INSTRUCTIONS) Your first question comes from the line of Richard Farmer with Merrill Lynch.

Please proceed.

Thank you.

Dan, I'd just like to ask on the macro environment, I think the question on everyone's mind here is what's driving the outlook, I know you talked about the lack of backlog, but just going to ask you to elaborate a little bit more on the reasons for the outlook and I guess a few different dimensions, partly by geography, I know you mentioned the U.S.

But anything you can do to elaborate there, also industry verticals as well as the timing of the weakness, as you sense that was it just March or was it also April and has that persisted into May so far, and in addition, the degree to which you think that this macro environment is at all reflecting your own business or is it really just truly for the industry that you're seeing out there?

Thanks.

Richard, let me see if I can add some more color to this.

First of all let me start with the timing.

Maybe that's the way to really look at this.

Through the first half of Q4, it felt very much like Q4 of last year.

We were running a little bit behind linearity, but nothing real major.

In fiscal year '06 we saw the last six, seven weeks of the quarter get really strong and that never happened here until about the last four weeks.

So everything kind of slowed down during the calendar month of March and I know we had a really good bookings activity, I think the first time we booked 0.5 billion in a month in April so it was really strong, but it wasn't enough to recover the shortfall that occurred in our fiscal month of March.

And some of the other storage vendors, this is not unique to NetApp.

The entire industry slowed down if you listen to the calls from some of the companies you follow, they inferred the same kind of thing and their growth rates were significantly lower, right?

AMC storage had I think 6%, HP's was around 10, and so we did 30, right, so this is not exactly that the bottom fell out.

The way to think about this though is typically our business has a surge in bookings in Q4 which gives us a high backlog level going into Q1, and that converts into revenue during the fiscal Q1.

That backlog level is not there entering this particular quarter as a result of the slower bookings in March.

And therefore, we would go back to what's our normal seasonality in bookings?

It's down somewhat from our fiscal Q4 and that's the way the forecast is rolled in now and May as I think Steve said in his comments in the conference call, we can't tell a lot about a sales cycles and bookings rates in May.

That's a reorganization month for us.

We got a lot of new people getting new territories and structures and comp plans and I know we take them out of the field for a week for sales kickoff so May is always a very difficult month for us to use as a basis for any kind of forecasting.

The pipeline looks very good.

We've got plenty of opportunity there to cover the forecast that we shared with you.

It assumes not only a normal conversion rate and it assumes that the margins stay good as well.

I mean, we see the product gross margins stand in the same kind of zone it has been.

It's very strong.

So this is truly, March was soft in bookings, therefore backlog is slower than normal for Q1 entry and that's going to convert to Q1 revenues and everything else with that one exception this is an air pocket to slowing through the system but everything else is really very solid.

Okay, thank you.

Your next question comes from the line of Ben Reitzes with UBS.

Please proceed.

Yes, Ben Reitzes, could you talk about, well I'm going to see, I don't know if you gave the numbers by geography but also with regard to virtualization, there's an emerging negative thesis that NetApp could perhaps be adversely impacted by server virtualization and that that market is moving to iSCSI SAN and perhaps you might have been hit by that.

Could you talk about as the emergence of server virtualization takes place whether NetApp is seeing kind of an air pocket in demand potentially because of that?

Just the inverse.

We are really accelerating our relationship with VMware, because we think we are the best positioned in the industry to take advantage of that.

We saw this coming.

We bet a lot on iSCSI, and one of the goals is to be the iSCSI leader and I've argued for some time that the right infrastructure for storage as customers move towards virtualized servers is in fact ethernet and this is probably the strategy, this is unfolding the way we expected.

We were thrilled to have the team from VMware at our sales kickoff, and to announce that we are a part of their global partners strategy, this is a marriage made in heaven from our viewpoint and no, it's just the inverse.

The double negative here.

It does not have a negative impact on our demand.

It has a positive impact and puts us at an incredibly competitive position versus the alternatives.

Do you think that any of our competitors have size throughout their pushing iSCSI and infrastructure?

Well, I'm asking you.

You tell me.

I can't see it.

And just a suggestion, if you can go through the geography numbers again maybe in another question, I'd appreciate it.

Thanks a lot.

He's got them right here.

I have them right here.

So Americas represented 56% of our business, this is revenue based, EMEA was about 34%, and Asia-Pac was about 10%.

Sequentially, the Americas was up about 15%, EMEA was up about 6%, and APac was up about 4%.

I point out that EMEA came off an incredibly strong third quarter.

Seasonally they should be down in our fiscal Q4 and Americas should be having a blowout, that's generally the way we see it.

I always get the question every year what happened to EMEA in the fourth quarter, and even the Americas grew at 15% sequentially, it wasn't enough to make up the plan.

Thanks a lot.

Your next question comes from the line of Harry Blount with Lehman Brothers.

Please proceed.

Hi, guys.

I do clearly think the most important question here is the long term growth rate.

I think that has a big impact on your stock, so with that as a backdrop, I want to come back to the question of trying to narrow in specifically on what happened and I've heard you pretty clearly that it was principally U.S, I heard you pretty clearly that it was March quarter.

What I'm wondering about is you indicated that the tempo of the pipeline still looks pretty good and I'm trying to get a sense of if there was a certain competitor that you saw a specific lengthening of the close cycle that has now improved and if the backlog for the IBM business specifically which you said met expectations, if the outlook for that business remains intact in the past, you've given some kind of perspective on what you thought IBM would count for as a percent of revenue.

I'll tell you what I believe.

It had nothing to do with any competitor.

It had nothing to do with anybody like IBM.

This was strictly macroeconomic.

Our win rates as I pointed out stayed high.

In fact, our frequency and engagement against EMC was up and our percentage of wins stayed fixed.

Our win rate against Hewlett-Packard went up.

Everybody performed as expected except everything came in under the normal close rate.

Our conversion rate of the pipeline during the fiscal month of March was lower than normal and we have no experience since March which we can base solid forecasts going forward.

April was a huge month, but like Steve said, there are a lot of incentives that work in April and it's very difficult to determine what a normal pace would be.

May is a slow month, it always is and it's very difficult to determine whether that would be a representative pace for the quarter.

We believe it would not.

So we believe that assuming a normal conversion rate of the current pipeline, we have plenty of opportunity to cover the forecast we gave you, and that if that is the case, we'll return to a normal model probably in Q2, but you're asking us to speculate on things that we don't have a good basis for at the moment.

I can guarantee to you it was not competitive.

I can guarantee you it was not channels or partners, or any other kind of competitive forces in the marketplace, nor was it in any way related to IBM.

All of those things are tracking right to the norm.

What happened here was the conversion rate from opportunity to booking took longer, and therefore, everything slowed down and the translated right to the system into not enough backlog coming into Q1.

Dan, the question still is out there though, in terms of the long term growth rate and I know you guys say you're not going to give that long term perspective but I guess just to provide a bit more color around your guidance on this quarter.

Any additional color around your assumptions for IBM and the new product launches for the July quarter guidance would be helpful.

Thanks.

No, those are not particular materials in the forecast going forward.

It's strictly right to the pipeline and velocity of closure.

It's sales cycles and that's it.

Everything else is not particularly material in this outcome.

Right to the pipeline and conversion rate of that pipeline to solid bookings is the key.

That's definitely sales cycle rate and we believe that's tied right back to macroeconomic conditions.

Hopefully everybody feels better about the economy now, if the Stock Market is an indication of that then they've certainly recovered from the March periods but if you'll recall in March, every vendor was seeing a slowdown, Greenspan was on the stage talking about probably a recession in the U.S.

economy in the second half of the year and everybody was nervous about the impact to the consumer spending of the blow up in the housing market, et cetera, and it's very clear that the U.S.

enterprise accounts got very cautious.

I believe that caution is largely behind us, but I don't have enough metrics to look at to ascertain that.

My recollection, I mentioned that EMC saw the slowdown but I think it also was referenced by IBM, Cisco, Seagate, and they all saw the same thing.

This was not unique to NetApp.

Just so happens that our fiscal slowdown that occurred, an economic slowdown occurred in March, it's our fiscal fourth quarter, which has got so many other effects going on it's really a spillover case.

Okay, thanks.

Your next question comes from the line of Bill Shope with JPMorgan.

Okay, great.

Thanks.

Obviously it's pretty clear this is just U.S.

centric but did you see any signs throughout the quarter there was any weakness spreading into the international markets and just to give us comfort can you give us some color on the conversion activity you saw in the international markets throughout the quarter?

No, internationally especially Europe was strong again.

It met our expectations but as Dan said the quarter before they had explosive growth but once again this quarter we are very very pleased specifically in Germany and the UK had great quarters, so they came through exactly as we expected and A-Pac was what we expected.

The difficulty that we ran into was short-term in North America and as it came on at the end, in the way it converted it just didn't happen in time.

Okay, thank you.

Your next question comes from the line of Aaron Rakers with A.G.

Edwards.

Thanks, guys.

I apologize for beating a dead horse here, but I guess I'm a little bit confused because if I look at the numbers for North America, it looks like your growth is actually the strongest in that region this last quarter and I'm trying just to understand where the contradiction is in terms of your discussion around March being very much weak in the month of March and the fact that actually North America looks to be relatively healthy, and maybe again just to go back on the context of EMC competitive rates that increase and just maybe a little bit more color on what you're seeing from them specifically, the new products, what is it that's causing that dynamic?

Thanks.

I'll give you two answers to the first half of the question and that is that what you look at is revenue, we reference as bookings and backlog.

You realize those two are not the same at a given period and the mix does vary period to period, and so the other half of the answer is America had to be stronger.

If you look at our seasonality which is what I pointed out, go back to fiscal year '06 and take a look at sequential growth rates and things like that, the Americas was the driver for very strong fourth quarter on very strong sequential growth rates, and 15%, the Americas last year, it was 57% of the mix one year ago.

And that's the kind of number they had to put up and that wasn't there this year and furthermore what you see is a decline in backlog of a fairly significant percentage which is primarily going to show up next quarter and softness in America's revenue.

You can't correlate directly in a given quarter bookings and revenue.

They don't match.

They don't like up.

That's the idea of backlog.

That's helpful.

Thank you.

And to the second question on EMC meet rates if there's any additional color you can provide there in terms of what specifically you're seeing from them now?

I don't think that Dan was saying we're seeing so much from them as witnessed by the margins staying very very high.

Obviously, they've determined they were going to drop the pricing level against us two or three years ago.

There's no change in behavior but the fact of the matter is we're attacking them on many of their home courts and we have to and we have to keep taking share from them and those engagements are going to take longer because you're ripping something away from somebody, and in fact, I was in UK recently and I got told by four major banks that we used to say we had a primary and secondary supplier and now we think we have two suppliers and want you to compete for everything and we are finding ourselves up against them and very much their strongholds of putting them on defense a lot and those are tough battles but the fact of the matter is this is what we have been doing for the last year so we need the competitive engagements to continue to grow to keep our growth rate going, growing against them, growing against HP, but if the win rates stay solid and you keep engaging, things should work out the way they always have.

We're getting invited into more large enterprise deals, that was the point, and guess who the incumbent is typically in those deals?

If there's a $2 million opportunity I guarantee you the big guys are there and those are the ones we're getting more access to so from our viewpoint I'm with Tom.

This is all good news.

Thank you.

Your next question comes from the line of Tom Curlin with RBC Capital Markets.

Please proceed.

Good afternoon.

Can you hear me?

Yes.

Can you, obviously visibility is sort of a key question here, so are you saying you have essentially no shippable backlog going into the July quarter?

No, I did not say that.

I would like to make sure it's very clear to the rest of the world that that is a fairly inflammatory statement.

I would appreciate you ask the question in a much more balanced way.

I did not say that.

We didn't come close to inferring that.

I'm not sure where you conceded that unless it was to try to put a negative spin out there.

No.

What I'm trying to get to is so let's look at it this way.

Is that level higher than if you go back two years going into the July '05--?

Let me help you here.

Let me give you some kind of quantitative metrics.

Typically going into the quarter we would have somewhere in let's say the high teens of that total monthly or the quarterly build plan in our backlog, but going into Q1 we typically see it approaching the high 20s for some of the quarter.

Right.

Roughly 10% is the differential.

We are in the high teens, we are not in the high 20s.

Okay, so that sounds, that still sounds like if you go back to two years ago the July '05 quarter going into that quarter do you feel like you have more shippable backlog?

We went into that quarter with a normal Q1 load and then we kind of had a self-inflicted wound associated with the conversion of our product line, the introduction of the 3000 that caused the sales cycles to really stretch.

That was a similar kind of case we saw in Q4.

Sales cycles stretched out.

We couldn't book all the new business we had to have but that was strictly caused by us.

This one wasn't anywhere caused by Network Appliance.

This was caused I believe by macroeconomic conditions.

To Dan's point, just to be more quantitative, in the three prior years, we've been somewhere between 30% and 27% of the next quarter, i.e.

the first quarters revenue requirements in our deferred backlog.

This quarter to Dan's point we're in the high teens.

When you say that's shippable plus scheduled backlog or just shippable?

That is factory load.

That means that is the product which is scheduled to be shipped in this upcoming quarter.

It does not include deferred.

Right.

Deferred is in a totally separate category and I should point out too, that means we don't have to rebuild any backlog in Q1.

You understand what I just said?

Normally we see it surge up coming into Q1 and it drains down going to a normal high teens level in Q2.

We are in the high teens right now.

Okay.

I think I follow that, so you're saying you have more backlog or I thought you said you had less backlog going into Q1 relative to the plan than normal?

That's what I said.

That is correct.

Next question, please?

All right, thank you.

Your next question comes from the line of Dan Renouard with Robert W.

Baird.

Hi, thank you.

Just following on your comments, Steve, about the -- Steve, and Dan, if you have a normal progression in Q2, you have talked historically if your growth rate slows, you'd be willing and proactively looking to slow your investment such that you get your operating margins up.

Are we reading into that?

It sounds sort of like you're saying you're not planning on that today but is it fair to assume that you would do that, coming into Q2 if the growth rate didn't bounce back like you're hoping it will?

We do not believe that the opportunity has gone away for us to sustain essentially the 30% range year-over-year growth rate.

We think we had a temporary problem that passed in March and therefore, as soon as we get back to our target business model of 15.8 to 16.4 operating we would expect to grow the expenses to continue to invest to drive the top line growth.

Okay, thanks.

Your next question comes from the line of Kevin Hunt with Thomas Weisel Partners.

Please proceed.

Hi, thank you.

A couple things.

I don't know if you, I think I might have missed you said the IBM percent in the quarter and then my question really was can you give a break down of what drove that deferred revenue strength?

Can you kind of help on that, why that was up so much?

Well, we've decided we're not going to continue to give specific numbers on IBM or individual product lines in EPG, individually, they are each too small to really worry about.

You got to keep in mind, IBM is like the fourth or fifth largest reseller we have after Arrow, Avnet, Fujitsu Siemens, and Fujitsu so let's not get too focused on the IBM number.

So as far as the deferreds are concerned, we typically experience fairly strong deferred growth as we've seen over our past numerous quarters type of thing.

This quarter we saw an increase in the mix of deferred and particularly during the last couple of weeks and Dan alluded to it in his commentary when he talked about the strong rate of growth we saw in the software subscription, and it was indeed software subscriptions that was the difference here and so all of that deferred backlog, all of that deferred bookings to the extent that we were able to ship it or they were renewals or whatever the case may be, we recognize only a portion of that in the current period and as you know we recognize the rest of that revenue ratably over the period.

Okay, so thank you.

Your next question comes from the line of Chris Whitmore with Deutsche Bank.

Please proceed.

Thanks.

Hoping to get any color on vertical markets that were particularly weak during the course of the quarter and secondly, can you talk on competitive response from a pricing standpoint to the softer conditions last quarter?

Thanks.

In the vertical mix it looked very much like a typical quarter.

High tech led it with about 20%, Financial Services right there on the 18 to 20% range, governments around 12, telcos around 11 or 12, energy at 8 or 9.

It was a typical quarter in every single way from a vertical perspective.

On the software pieces, I mentioned there's been tremendous demand for software of two forms.

I think of our software, it is basically providing two classes of capability.

One is integration with the applications, SpamManager, Oracle, SAP, and that was very strong and then the other one is the kind of the replication technology and all of the data protection and data recovery kinds of capabilities, SnapLock, SnapRestore and so on and that was very strong, so I'm not sure I understand the question but demand for the software is what I believe drove the consumption of the storage.

In terms of the competitive response, did you see increased pricing by your competitors during the course of the quarter and secondly can you provide any color on cash flow expectations for Q1?

Thanks.

I'll talk about the competitive environment.

I finished a ten week trip right before our kickoff and I didn't see the competitive environment changing at all.

I see us involved in many many engagements at high levels than we ever have been before.

The price -- it would be different if we were losing deals, and we found that the competitors are doing something taking away deals we thought we were going to have.

That's not what we saw.

What we saw is in some cases stretched out just until April and some cases stretched out a little longer but in each case we're engaged and competing and our pricing strategy hasn't changed at all.

We didn't do anything different than we've done before nor do we think we have a need to nor do I think it would have changed a result.

As far as cash flow is concerned in the first quarter we typically don't provide guidance on that.

I will tell you this.

If you look at our accounts receivable and you look at the 57 days, remember that every day of receivables is $8 million in cash, in fact some of $9 million in cash, so even if we just took it down to 60 days, we're going to be generating a bunch of cash out of that current asset.

Your next question comes from the line of Bill Fearnley with FTN Midwest.

Please proceed.

Good afternoon.

Switching gears a little bit here.

Wanted to ask two questions for you, first if you could give additional commentary on the Decru business and then also, if you could give some more color on why the sharp increase in R&D this quarter, should we be looking at new products, new technologies here in the near term, the longer term or a balance of both?

Thanks.

The Decru business really suffers from I think two things.

One is that the question of data securities seems to have moved in many buyers minds from one of protecting data in the data center to protecting data leakage or data on laptops that walks out of the building.

Probably the thing that hit the demand for the Data port product the most was the VA episode where they lost 28.5 million records off of a laptop, and that kind of caused everybody to change their focus a little bit.

The other factor is that inside the data center, I think many customers are considering a variety of new alternatives including the encryption integrated into the LTO-4 tape drives are starting to come to market.

I believe they are going to conclude the issue is not encryption.

The issue is key management and those solutions don't have a very robust key management scheme, so I think they will come back to the Decru model but at this point in time I'd say the sense of urgency around buying has diminished and the alternatives and customers has increased, so we're just seeing a lot of tire kicking, we're seeing a lot of demos, but we're not seeing a lot of order conversions nor are we seeing losses.

That's the other thing.

It's not as though these deals are turning into losses.

The customers are now just taking longer for evaluation and are much slower to make an architectural committment.

And could you comment on the R&D spending as well?

Sure.

Steve here.

Thank you.

The engineering spending was up about just over $11 million, about $11.5 million for the quarter-over-quarter.

That was virtually planned, I mean entirely planned.

The bulk of that about 60% of it was headcount related.

That has to deal with the timing of the heads that we added in the third quarter as well as timing of all of the folks that joined us in the fourth.

The other, the probably unusual things if there's anything unusual about this is that we did have quite a bit of development project expense and equipment related expense, about $3.5 million there.

We were only expecting about maybe $3 million, so we spent a little bit more on project material and I'm sure it has to do with the cycle of project development products, our cycle of product development.

Thanks.

Your next question comes from the line of Brent Bracelin with Pacific Crest Securities.

Please proceed.

Thank you.

I had a follow-up question on your philosophy around hiring, two months ago at the analyst day I think you articulated this large opportunity in the enterprise data center with some architectural changes taking place.

Your desire to increase kind of the pace of hiring, now as you sit today with more questions on the macroeconomic environment, are you going to take a more balanced approach to hiring in fiscal 2008?

How do you really think and how should we think about kind of hiring this year relative to kind of macroeconomic trends?

Oh, our primary metric that we're driving for is to manage the business to a 15.8 to 16.4 operating income and we believe that gives us the opportunity to both not only return growth and earnings to shareholders of scale to revenue but also drive the revenue at the maximum growth rate possible.

In the near term, we're obviously going to slowdown the hiring until we get back to that level.

I'd estimate we're going to hire somewhere around 200 to 250 people this quarter and the philosophy there is that many of those people had outstanding commitments, some are new college graduates, et cetera.

We are not going to reneg on those commitments, we're going to continue.

Some of them will also be conversions from contractors although the temporary employee is already on the expense structure.

So we'll proceed down that path but we're going to limit the new hiring until we get the expense level back in line with that number which produces a 16% roughly operating income, and that's the next major objective, so let's push the top line up until we're back in balance and then take an assessment and move from there.

Thank you.

Your next question comes from the line of Katie Huberty with Morgan Stanley.

Please proceed.

Can you go back to the iSCSI market and compare and contrast the competitive landscape between NAS and iSCSI markets and then touch on whether you think you can garner your typical NAS market share in the new iSCSI SAN segment?

Well, this is Tom, and a couple things about the iSCSI market.

One of them is network-based storage is the strength of the Company and I think that we've got some skills and capabilities there that our competitors don't have.

So what we see going back to the previous question on server virtualization is the technologies that lend themselves to iSCSI as opposed to NAS and opposed to fibre-channel we're positioning ourselves and we've been advocates of iSCSI for a long time to go after that.

So when I look at VMware and server virtualization, and application mobility, the ability to connect over an IP connection whether it be NAS or SAN, or IP SAN, is a compelling advantage that we have that nobody else has so when we think about how we partner with VMware and other environments that are similar, Microsoft Exchange.

We're seeing more and more Microsoft Exchange environments go iSCSI as well.

We're doing many of hundreds of thousands of seats in Europe right now that's all being implemented in iSCSI.

So I think some of the early adopters had to be driven by the applications themselves, whether it be Microsoft acceptance, whether it be VMware's acceptance but from a technology perspective, I think we feel really good not only about our current product offering but how it plays into our strength.

Network expertise is one of the core competencies on the Company and any movement towards IP based storage I think only really plays to what NetApp does better than anybody else.

That's the technology we want to see grow and prosper.

You should understand our forecast for the iSCSI market and how it grows don't match that of some of the industry analysts.

They would argue that the iSCSI adoption is going to be very heavily concentrated in the low end price points, price points under 25 K, and while we do see adoption there we believe it also has a very rapid adoption at the enterprise level alternative to fibre-channel SAN, we're seeing already 10 gigabit ethernet iSCSI infrastructure deployments, as Tom said, a lot of enterprise deployments going into the Exchange environment are on iSCSI, and we see a bifurcated market.

Now if you compare that to the NAS market, there was no NAS market under 25 K.

If you didn't have a significant amount off Data you didn't need a NAS solution.

Just go use a Microsoft or UNIX Windows file server, and so the under 25 K market didn't become, if you will an interesting NAS market for a long time after NAS was developed as an appliance.

And if you look historically you saw a number of appliance vendors like Snap and so on try to build a market there unsuccessfully, so it's got a very different structure than does NAS.

iSCSI is I think on appeal there because there's a number of applications at the small and medium business level, SQL server base, exchange base, whatever but iSCSI is going to be a very attractive solution and the core of that does not exist or did not exist, and at the enterprise, NAS was slow to get into the great big enterprise environments and iSCSI has to get in quickly.

Just two trends I think, just the Exchange 2000 and the proliferation of VMware both lend themselves really well to iSCSI and I think it's causing customers to reevaluate and reimplement a lot of their infrastructure that they may have put in place five years ago and as a result I think that plays directly into our hands.

So in terms of our market share in iSCSI, our expectation is that we already are, we intend to remain the market share leader in that space.

Great.

Thanks.

Your next question comes from the line Shebly Seyrafi with Caris.

Please proceed.

Thank you very much.

So I'm trying to figure out how much of the near term guidance is due to March, the month of March itself.

For example, if March came in as expected and April and May came in as occurred, would you have guided your normal like low single digit growth sequentially and maybe you can also touch on to what extent is this guidance impacted by the product transition to the low end, because your FAS 200 grew 6%, that was much lower than your 3000 and 6000 line--?

That's a non-factor.

That has absolutely no weighting in this analysis whatsoever.

It's a non-factor.

Let's recap here.

Our backlog is low by about roughly 10% of what the product revenue would have to be, factory revenue would have to be so it's roughly $70 million.

If that was there, we would have guided a sequential increase in revenues in that amount, right, so instead of being 750, we kind of guided you to it would have been 820 and it would have been right back on the plan.

But to be clear, if March came in as planned--?

That's what I just said, yes.

Then you would have guided up, okay.

Thank you very much.

Sure.

If the quarter came in as planned, right?

I'm just saying the month of March.

Okay.

If March was on plan and April was on plan--.

April as occurred is what I said.

That's like saying if the waves weren't there, the water would be flat.

All I'm saying is it a one month issue versus a two or three-month issue?

We made up ground in April.

Part of that ground we made up in April is because deals went out of March so you can't say March was on plan and April was on perform because part of the April business was thought to slip out on March.

If we made the quarter we would have another $70 million of backlog.

One last point.

I'm getting that the U.S.

enterprise did pick up recently in the last few months, two months, and are you sensing that as well?

It's very difficult for us to tell what the macroeconomic back drop is because we have so many effects going on in the months of April and May.

We had a very strong April.

Americas had a very strong April.

But you know, they are already behind and I got to tell you, I have a very very driven sales team, and they are on all kinds of escalators and things like that to finish the fiscal year, go to club, make their goal.

I mean, they are going to do anything in their power to close business during the month of April.

That is not a way of us being able to interpret what was going on in a macroeconomic environment.

I'll leave that one in your hands.

That's an area that I think you probably have better visibility to.

I could tell you the sales team killed it in April but they would have done that if we were headed towards a depression.

Thanks.

Your next question comes from the line of Brian Freed with Morgan Keegan.

Hi, guys.

I think you have already implied this in your comments but when you look at NetApp over the last several years, you've consistently delivered growth in the range of 3 to 4 times the overall storage market, and while you can't forecast the long term kind of macroeconomic, do you feel confident that within the context of relative growth versus the storage market you can maintain kind of the current trajectory relative to your peers?

I do.

I believe that absolutely and I think everyone in the Company does too, that probably saw a slowdown in terms of total storage spend in the industry but we have more than our fair share in many ways.

Look at some of the competitors and their growth rates.

We have more than three times EMC's and that's not bad.

Okay, thanks, guys.

Your next question comes from the line of Laura Conigliaro with Goldman Sachs.

Please proceed.

Great.

Just a few questions.

Did you give any thought as you were watching March develop to slowing down your hiring somewhat or was your hiring very front end loaded?

Also, you mentioned macro facts of course and most companies, many companies saw macro effects in the U.S.

As you did as well, but it seems like the impact proportionally was a little bit larger, at least that you saw.

Any thoughts about that and then just another question after that.

Actually, I think all of us felt like even though March was slow we still had a good chance of making it up in April.

We actually kind of came close.

I mean, we're off by roughly 70 million or something like that in the backlog sense, and actually the bookings came in even stronger as Steve said.

We made up more in a bookings sense and the mix was heavily shifted towards deferred revenues at the end, so in the hiring question, yes, the hiring process is one that takes us about two or three months to crank up and two or three months to shut down.

I just mentioned we're going to hire 200 people this quarter even though we shut off the hiring (Inaudible) and so the hiring is committed well in advance, but we didn't even try to shut it down until basically the 1st of May.

We really thought we were pretty much on plan.

It was really only the last two weeks I think I concluded we weren't going to have enough backlog coming in.

And one more question.

I think Tom mentioned that Europe met expectations.

Did it actually meet your expectations in constant currency since the dollar weakened over the course of the quarter?

Absolutely.

The European win rates against all of our competitors have gone up.

We're just on fire in Europe.

They are killing it.

Thank you.

And your final question comes from the line of Glenn Hanus with Needham & Company.

Please proceed.

Just to shift gears.

Could you update us or refresh me on when to anticipate updates to the high end and the mid range?

I guess Hitachi just upgraded their high end.

Can you give us what's the cycle there look like now?

Well, I don't think we are going to pre announce any products but as far as the mid range goes, the 3070 and th 3040 have both been introduced in the last six months, one in November and one in February and in fact, if you look at our overall product line, the 6,000 was actually introduced in May of last year, the midrange, the 3040 and 3070 were introduced around the turn of the year and as we said on prior calls, again reiterate, we're going to introduce the low end in this current quarter.

So we're going to actually be sitting here in this quarter with the entire product line at least from a platform perspective less than a year old and I would say that in the entire history of network work appliance we probably didn't have three separate product lines all less than a year old at the same time.

So I actually feel good about our current product lines.

As far as when we're going to upgrade the high end, I'm probably going to pass on giving any expectation on that except to say that we're going to keep it current, we're going to keep it competitive, but I don't see any signs of it running out of gas.

We actually just saw a 35% sequential increase in the FAS6000 sales just in Q4 alone, so--.

Plus the hardware platform, I actually feel really good about our positioning.

At the very high end our customers tell us they don't want us to turn it over that frequently.

It takes them awhile to kind of certify it and get it in production, do all of those other things and we would like to have a longer life, if you will, and they prefer we move to a two to three year cycle, so you shouldn't expect any near term on the high end.

Thank you.

Ladies and gentlemen, at this point, our time is up.

I would now like to turn the call back over to Dan Warmenhoven for closing remarks.

Thank you all again, for joining us today on the conference call.

We'll look forward to speaking with you in 91 days from now.

Thank you, everybody.

Bye-bye.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.

Good day.